Facebook employees could be getting big tax bill after IPO

Facebook CEO Mark Zuckerberg gestures while speaking to the audience during a media event at Facebook headquarters in Menlo Park, California. (Robert Galbraith/REUTERS)

Facebook founder Mark Zuckerberg owes an estimated $1.1 billion in federal and state taxes and, while the amounts won't be as big, it's a safe bet that hundreds if not thousands of his colleagues also face daunting tax bills this year in the wake of the company's IPO.

For some, the pain at tax time shouldn't be too bad if they followed the advice of tax professionals like Stanley Pollock, a CPA with offices in Oakland and San Francisco. He would have told them to begin preparing for Monday's tax deadline by selling at least some of their shares as soon as they vested in order to cover their
"They're now sitting on fewer shares, but at least they won't go broke," Pollock said.
But for some unlucky employees, the company's tumbling stock price has created a double hit.
A few may not have sold any shares, thinking future increases in value would give them enough money to cover their taxes, according to Robert Hendershott, a Santa Clara University finance professor.

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The practice worked for shareholders and employees when Google's (GOOG) IPO price of $85 in 2004 went on to double, then double again, Hendershott said. They could sell shares at much higher prices than they had paid for them and use that money to pay their taxes.
But Facebook employees who took a similar approach have seen a different outcome. Under the tax code, they have to pay capital gains taxes on the original value of their shares, not the value of where the stock is trading now.
"There would have been a 'gain' but no actual gain and they could end up owing hundreds of thousands of dollars in taxes," Hendershott said. "My guess is that most employees who are underwater don't have a tax problem yet until they exercise their options. But anyone who locked in before the price bottomed out put themselves at risk."
It's a lot like being an underwater homeowner, said Hilary Martin, a San Jose financial adviser who specializes in "sudden money clients" who win lotteries or get big inheritances or stock windfalls.
Just like homeowners who get upside-down on a property when they owe more on the mortgage than they can sell their home for, some Facebook shareholders probably found themselves in an unenviable position known as "out of the money" when they locked in to protect themselves against capital gains taxes, only to see share prices plummet, Martin said.
"I guarantee at least somebody (at Facebook) was forced to sell their shares when they were out of the money," she said.
While many publicly traded companies issue employees stock grants or options, Facebook used "restricted stock units" that Pollock said work much like stock options.
Facebook's IPO price of $38 rose no higher than $38.23, then later plummeted to as low as $17.72 a share. It closed Thursday at $28.02, up 1.6 percent.
Only the IRS knows how many Facebook employees, former employees and shareholders will have to pay taxes this year -- and how much -- as a result of Facebook's May 18 IPO.
But in one case, Facebook's chief operating officer, Sheryl Sandberg, offered a hint in an April 3 filing to the Securities and Exchange Commission in which she reported that she reserved 364,689 shares of Facebook class B stock beginning April 1 for tax purposes.
Marin reviewed the filing for this newspaper and said Sandberg used the shares "to show the federal government in good faith that she will pay her tax."
At an April 1 closing price of $25.53, the value of Sandberg's shares at the time was more than $9.3 million.
Zuckerberg is taking a huge hit because, as a company founder, he was able to buy 60 million shares at a cost of only 6 cents a share on the day of the IPO, meaning he netted $2.3 billion that the IRS considers taxable wages, according to an analysis by CNN Money.
Tax problems for newly minted millionaires is an old story in Silicon Valley.
During the tech boom of the late 1990s, "hundreds and hundreds of people owed thousands and millions in taxes when they exercised their shares when the price was high, then the prices fell," Martin said.

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